WASHINGTON – President Bush’s warning that Social Security faces a looming financial crisis is based on the assumption that the U.S. economy will grow by only 1.8 percent each year, on average, for most of the next 75 years.
Since 1950, the U.S. economy has grown, on average, by 3.5 percent per year.
If the economy continued to grow over the next 50 years at a rate anywhere near the past pace, Social Security wouldn’t face a financial crisis, though it would require small adjustments to balance its income and costs. Many economists think that such a healthy rate of economic growth is more likely than not. They warn that President Bush is making a case for Social Security restructuring based on improbably pessimistic forecasts about everything from immigration to fertility rates.
“The last couple of decades should have been a humbling lesson that we really cannot predict the future,” said James Glassman, senior economist at JP Morgan Chase in New York. “Logic can be debated. It is not God’s truth and set in stone. It is a debatable set of assumptions they are making.”
By law, Social Security trustees must anticipate the retirement system’s financial needs over 75 years. Because so many unpredictable variables could affect the U.S. economy over time, predicting a crisis 50 or 75 years from now is little more than a shot in the dark.
Just eight years ago, Social Security trustees projected that dismal annual economic growth averaging 1.3 percent would create a financial crisis for the system by 2029. At that date, Social Security wouldn’t be able to pay full benefits to retirees. Trustees assumed that U.S. economic growth would slow to 2 percent annually between 1998 and 2004, and remain weak afterward.
Instead, the U.S. economy grew by 3 percent annually, on average, in that period. That led trustees to push back their estimated “crisis” date – when Social Security no longer could fully pay retirees – by 13 years, to 2042.
Fast-forward to 2004. Because short-term growth turned out stronger than they’d assumed, last year the system’s trustees boosted their long-term forecast. They now assume that annual economic growth from 2015 to 2080 will average 1.8 percent. That’s better than 1.3 percent, but still well below what most economists forecast.
The nonpartisan Congressional Budget Office, for example, uses slightly more optimistic assumptions on inflation and employment, and as a result estimates that Social Security will be able to pay full benefits to retirees until 2052.
The trustees base their conservative economic forecast on assumptions that employment, average hours worked and productivity – hourly output per worker – will show significant downturns in the years ahead. Many economists disagree on each point.
If any assumption is off by just fractions of a percentage point, that results in a miscalculation of how much money will come into the Social Security system from wage taxes. That, in turn, determines whether there’ll be enough money to pay promised benefits to tomorrow’s retirees.
Trustees project that the national work force will shrink as the baby boomers – those born between 1946 and 1964 – retire and the number of active workers declines. They project over 75 years that growth in the labor force will slow to just two-tenths of 1 percent annually, on average. With fewer workers, productivity probably would fall too.
The trustees must be prudent, but even so, many experts think their expectations are too pessimistic.
“I think it is more likely that these assumptions are too conservative,” said Jason Furman, a professor at Harvard University and former economic adviser to President Clinton.
Furman points to fertility rates, an important indicator of the size of the future work force. While birth rates have fallen in Europe and Asia, they’ve risen in the United States since 1976 and stabilized at two children per woman. Trustees see fertility rates falling to 1.95 per woman over time. They point to more female workers, high divorce rates and more women marrying later if at all. They may be right, but the past quarter-century’s U.S. experience says they’re off a bit.
Some economists also question their assumptions about immigration, which affects work-force size. From 1992 to 2002, when the U.S. economy was growing, legal immigration averaged 840,000 people a year. Trustees assume the flow will return to something near the number that entered from 1977 to 1990 – 580,000 a year. They project that legal immigrants will average 600,000 annually from 2024 through 2080.
But Glassman of JP Morgan argues that America’s experience suggests a different conclusion. Rising immigration, he said, partly explains why the U.S. economy grew by 3.2 percent annually since 1992.
“What we just learned is, if we do well, we are a magnet for workers,” Glassman said.
Michael Tanner, a Social Security expert at the Cato Institute, a libertarian research center that supports Bush’s proposed changes, is convinced that Social Security’s problems are much more severe. Our society is aging, the future work force probably will be smaller and the economy thus may well be weaker than previous norms, he said, so the president is only prudent in planning for such a future.
Besides, Tanner argued, focusing on economic-growth estimates misses a key point: Because people are living longer, they’ll receive government benefits for more years, driving up long-term costs.
“Life expectancy is far more important than economic growth in determining the solvency of the system,” Tanner said. “I think they are dramatically underestimating future increases in longevity. People retiring today are less likely to smoke than they were 10 years ago; all these things are going to lead to increases in longevity. And Lord knows what happens if they find a cure for cancer in the next 70 years.”
The Social Security system does face a funding squeeze as the baby boomers retire. Wage tax revenues that pay for benefits will fall short beginning in 2018, the trustees say.
Then the system will begin cashing out Treasury bonds in its trust fund to pay for benefits; the government probably will take on more debt to cash out the bonds, swelling federal budget deficits. That, in turn, will put pressure on Congress to cut spending on other federal programs.
“This is a definite problem, but it is manageable,” said Barry Bosworth, senior economist at the Brookings Institution, a center-left research center in Washington.
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